Italian, Spanish debt stabilises, Bunds hit five-month low

German Bund futures hit five-month lows on Friday on prospects of reduced US monetary stimulus, but Italian and Spanish debt stabilised after a deep sell-off the previous day. Greek government bonds underperformed other euro zone paper, with borrowing costs on debt issued by the bailed-out country surging to their highest since April after political turmoil dragged the sovereign back into the spotlight.
Despite the relative stability of some peripheral markets on Friday, analysts expected higher yields across the euro zone in the near future. Central bank liquidity has been one of the main factors behind the peripheral rally in the past year and together with the European Central Bank's promise to buy bonds via its OMT programme it has helped ease the pain of the euro zone crisis.
But on Wednesday, Federal Reserve Chairman Ben Bernanke said the US economy was expanding strongly enough for the central bank to begin slowing the pace of its bond-buying later this year, triggering a broad sell-off across assets. Bund futures were last 64 ticks lower on the day at 141.49, having tumbled 131 ticks on Thursday, their biggest daily drop since March. Earlier in the session they hit a five-month low of 141.45. Ten-year German yields were 5 bps higher on the day at 1.714 percent.
"Liquidity has been the reason why yields have been so low recently and there's going to be less of it," one trader said about the Bunds' performance. On Spain and Italy, he said "people still need yield and there's no reason to stop believing in the OMT." However, he said the increased volatility will scare many investors away from those markets. Carry trades, in which investors use cheap loans to buy higher-yielding assets, are only favoured by investors in times of low volatility. "The (central bank support) genie is out of the bottle and it will be very, very difficult to rally back from here," said Laurent Fransolet, head of European fixed income strategy at Barclays Capital.
Spanish 10-year bond yields were 1 basis point lower on the day at 4.87 percent, after rising more than 30 bps in the previous session. Equivalent Italian yields were flat at 4.57 percent. Greece was the hardest hit euro zone debt market on Friday, with its 10-year yields hitting their highest since April at 11.62 percent, before retreating to 11.31 percent, some 60 bps higher on the day.